By Tiernan Ray

Shares of Apple (AAPL) are down $45.15, or over 8%, at $505.35, as the Street continues to mull what to do with better-than-expected results for the company’s fiscal Q1, reported yesterday, that included fewer-than-expected iPhone sales, and a lower-than-expected revenue outlook this quarter.

As I noted last night, price targets and estimates are being lowered by many if not all analysts today. There were already two downgrades of the stock this morning, and another one arrived this afternoon, from Hilliard Lyons’s Stephen Turner, who cut his rating on the shares to “Long-term Buy” from Buy, even though he raised his price target to $600 from $580.

Turner cut his fiscal ’14 estimate to $$180.8 billion in revenue, and $43.22, down from $184.9 billion and $4.28.

The 51 million in iPhone sales missed his own estimate for 52 million units, but he’s still betting on some upside from the China Mobile (CHL) iPhone deal this quarter:

We expect Mac unit sales to increase 4% y/y to 4.1 million on a refreshed product lineup, a larger distribution network and positive Apple ecosystem effects. We are forecasting iPhone sales of 39 million units, 2 million above last year on strength from Japan and China. We continue to view China as very important to Apple and the deal with China Mobile as a long term positive. We expect sales at China Mobile to be less pronounced in the near term but expect the carrier to act as a long term tailwind as the carrier continues to build out its 4G services to additional cities. We have lowered our iPad unit sales targets as we were too aggressive in the previous quarter despite the addition of the new iPad Air and iPad mini.

Turner thinks there’s risk to iPhone sales, but that risk matters less over time:

Apple’s revenue outlook remains solid, in our opinion, without the addition of a new product category. If Apple launches a new product category we believe the stock would be significantly undervalued given gross margins are not overly affected by the introduction. We believe near term risks are significant due to the potential iPhone product cycle upgrade which could negatively impact gross margins. (Higher costs associated with larger screens etc.) Longer term we see less risk due to the recurring nature of the iPhone business. We also believe Apple will offer additional software and services that could offset hardware gross margin declines. Examples of these markets include mobile payments, advertising, content packages, video game sales etc.

The cash flow and capital allocation engine remains intact, and the valuation doesn’t reflect this. Despite Apple’s iPhone unit shortfall and tepid guidance, the company’s stable margin profile, healthy iPhone ASPs and loyal installed base allowed it to generate $22.7 billion in operating cash flow for the quarter. The company is now trading at a CY2014 free cash flow yield of 10%, despite the fact that it has returned over $36.8 billion to shareholders through buybacks and dividends over the past 12 months. We believe the company is set to substantially increase its capital allocation program in the next several months, as the company has $158.8 billion in total cash ($34.4 billion in the US) and further room for incremental leverage. Indeed, an incremental $50 billion to the buyback authorization is not unreasonable, and we believe this would further attract value- centric investors to the name.

He also thinks that it’s early in the roll-out of the China Mobile deal, and that it will still be important later this year:

The company has only ramped the partnership in 16 cities and expects to reach 340 cities by year end. As such, we believe this is still an important tailwind that provides a buffer to downside pressure on estimates, despite the March quarter guidance shortfall.

There’s more enterprise business to be scooped up, too, he thinks:

Apple noted continued enterprise momentum, with the iPhone now used in 97% of the Fortune 500, and 91% of the Global 500, and iPad used in 98% of the Fortune 500 and 93% of the Global 500. While the company frequently cites similarly impressive statistics every quarter, we believe the enterprise is fast becoming the next swing factor for smartphones and tablets. With the introduction of iOS 7, Apple began to address enterprise management and security with an increasingly app-centric approach that maintains the look and feel of consumer-only iPhones (in contrast to the more containerized approach pushed by competitors). As detailed in our report, Hardware: 2014 outlook: Secular realities come back into focus, January 8, 2014, we believe this could widen Apple’s already substantial lead in the enterprise.

And Shope thinks Apple may be more willing in future to produce a discount phone for price-conscious consumers:

When Apple launched the new iPhone 5c in September, we were disappointed that the company wasn’t more aggressive with pricing. This was partly mitigated by stronger demand for the 5s, but on the conference call, the company noted that “It was the first time we had ever run that particular play before, and the demand percentage turned out to be different than we thought. We obviously always look at our results and conclude what to change moving forward, and if we decide it’s in our best interest to make a change, then we’ll make one. Obviously I’m not going to predict price changes on the earnings call. “We believe Apple has the ability to lower the price of the iPhone to compete more aggressively in the midrange, and we believe the resulting elasticity would yield net profit improvements from such a move (despite a lower gross margin). We believe the company’s commentary and the performance for the 5c over the holiday quarter makes this more likely.

Shope cut his March-quarter outlook to $43.85 billion in revenue and $10.30 per share in net income, down from $45.92 billion and $11. For the full year, he now sees $184.76 billion and $44.90, down from $188.14 billion and $45.81.

Morgan Stanley’s Katy Huberty reiterates an Overweight rating on the stock, and a $630 price target, writing that “confirmation of new product categories in the near-future is likely to buoy shares.”

Among the questions Huberty tries to answer: is the growth of sales of Apple’s iOS-based devices slowing? No, she seems to conclude, it’s about in line with the recent past:

And like Shope and others, she urges investors to stick with the notion of new product introductions later this year:

If CEO Tim Cook’s acknowledgement of a new product category launch in 2014 isn’t evidence enough, a meaningful step up in R&D expense (similar to 2000 pre-iPod, 2006 pre-iPhone, and 2008 pre-iPad), and the clear discontinuation of the iPod line (to make room for new categories, in our view) provides confirmation. So, while we’d rather see a business that is accelerating (vs. the flat iOS growth we highlight above), transparency into meaningful product launches should help re- accelerate growth in C2H14 and put in a valuation floor in the $500 range (assumes Apple’s current 12x P/E on consensus CY14 EPS estimates that are likely to land in the $41-42 range).

R.W. Baird’s William Power reiterates an Outperform rating, and cuts his price target to $600 from $620, after cutting his estimate for the current quarter to $43.2 billion and $9.97 per share from $44.1 billion and $11.08. For the full year, he actually raised his outlook to $177.1 billion from $176.2 billion, “driven largely by relatively higher iPhone 5S mix vs. the iPhone 5C,” but cut his EPS estimate to $41.29 from $42.97, after cutting his gross margin estimate to 37.9% from 38.2%.

Concludes Power, “Following recent seasonal patterns, the next couple of quarters are likely to be challenging, though we would use weakness to accumulate positions in front of iPhone 6 and new category rumors.”

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There are 5 comments

JANUARY 28, 2014 4:16 P.M.

TJ wrote:

Everyone, sell your stock now! Fire Fire! It's like a pump in dump in reverse. They all dump, I buy, then it pumps. Apple losing 8% was the best opportunity I've had in a long time!

JANUARY 28, 2014 4:30 P.M.

ILoveEricS wrote:

Why is it that every analyst report has a line like "expect sales increase on product refresh..."? Isn't it a long foregone conclusion that this is a business based on continual product refreshes, with the more consumer/iOS stuff happening annually and Mac happening approx. every 18 months? These guys act like this is some sort of genius analysis at work when it's become like the auto industry--nobody questions (or fawns over) the fact that new models come out each year at roughly the same price points with slightly better features for the most part with occasional ground-breaking new products. Occasional. So much teeth-gnashing over obvious conclusions...

JANUARY 28, 2014 4:39 P.M.

John wrote:

Some hindsight, Apple had a monster year in 2011, going from a Dec 25, 2010 EPS of 6.43, to Dec 31, 2011 EPS of 13.87. One can choose to look at a two year EPS rise of 4.5%, or a three year rise of 125%, but the fact remains that 51 million phones were sold in the last quarter. That is like saying that every person on England bought an iPhone last quarter. These are huge numbers. I own Apple stock, and took today’s drop to purchase more. Saying this as both an user, and an owner, Apple please focus upon making the products you have rock solid. I do not care about new products. What I care about is making sure that no one is complaining about the products they have. Ensure developer relations are rock solid. Ensure iCloud “just works.” Develop a solution to the photo storage mess. Please continue to wow me with what I have, and as a user I shall keep buying. As an investor, I hope Apple bought a million shares today.

JANUARY 28, 2014 5:46 P.M.

david wrote:

the smartphone market is saturated. And, it is becoming commoditized. Unless Apple can reinvent itself, and / or bring a whole new product category to market in a meaningful way, its best days are probably behind it. Sorry Carl.

JANUARY 29, 2014 12:33 A.M.

Anonymous wrote:

Should Apple continue like this for another two or three years I am fine with that. Seriously.

Do you really expect in two or three years to see Google making any less than their current 92% profit from advertising? Ha. Think again.

About Tech Trader Daily

Tech Trader Daily is a blog on technology investing written by Barron’s veteran Tiernan Ray. The blog provides news, analysis and original reporting on events important to investors in software, hardware, the Internet, telecommunications and related fields. Comments and tips can be sent to: techtraderdaily@barrons.com.